Wednesday, 25 April 2012

Performance-Related Pay, does this approach still work?

One of the most,
arguably the most, used and at the same time controversial approach to
contingent pay is definitely represented by performance-related pay (PRP). A
survey conducted in 2009 by e-reward revealed in fact that 84% of respondents
having recourse to contingent pay schemes had implemented a performance-related
pay programme.

Essentials of PRP

The mechanism of PRP
is essentially based on linking individuals’ pay increases directly to the
outcome of their performance and the results these yield. This approach clearly
takes as axiomatic that two specific activities can be and are hence performed:

a) That managers discuss
and agree with their reports the objectives these should meet (CIPD, 2012);

b) That these targets can be objectively
measured over a pre-identified period of time, usually corresponding to one
year (Torrington et al, 2008).

The pay increases
eventually granted on the basis of the outcome of performance appraisals can
either be consolidated into base pay in the form of pay progression or awarded
by means of non-consolidated lump sums, that is to say bonuses (CIPD, 2012).

Making the case for introducing PRP

By reason of the
several objectives these arrangements potentially enable employers to achieve,
performance-related pay actually appears to be a particularly attractive
approach to manage the organizations reward budgets. As suggested by Torrington
et al (2008), PRP can in fact help businesses to:

- Attract and
retain good performers;

- Increase the
level of individual and organizational performance targets;

- Clarify individual
roles and tasks;

- Identify and
agree with individuals their possible development plan;

Despite Torrington et al (2008) also list the
enhancement of staff motivation amongst the benefits offered by the PRP
approaches, the provision of this effect as directly linked to the introduction
of a PRP programme cannot be indeed taken as axiomatic; the CIPD (2012), for
instance, considers establishing such a direct link questionable. As it will be
further discussed later, analysing this approach from the empirical point of
view, research has produced over the years conflicting results. These pay
arrangements, nonetheless, can reveal to be particularly effective for helping
employers to foster and embed in their corporate culture the concepts of
high-performance, equity and fairness (CIPD, 2012).

According to
Arrowsmith et al (2008) and Marginson et al (2008), performance-related pay
schemes, reinforcing the communication of the organizational aims and making it
easier for managers monitoring strategic objectives, can also enable employers
to produce positive results in terms of performance management. The Authors
also stress the significance of the role played by these pay arrangements to
help employers to curb the personnel costs. Whether developed in association
with low-base-pay-based schemes in fact the variable element of pay, and thus
the overall individual pay, can be managed and adapted by employers according
to the profit eventually made by the organization.

One of the consequences
habitually associated with the introduction of PRP schemes is the reinforcement
of the individual employment relations to the detriment of the collective relations
(Torrington et al, 2008). The introduction of these schemes is in fact likely
to weaken the unions’ bargaining power within an organization.

Essentially based
on meritocracy, that is to say a principle according to which better performers
should receive more generous reward packages vis-à-vis those who have contributed
less to the attainment of the organizational objectives, these pay arrangements
should represent the most sought approach by both employees and managers. It could
hence be contended that directly linking salary to performance should
ultimately represent the most widely acknowledged and universally appreciated approach
to reward.

As claimed by Behn
(2004), it is actually hardly imaginable linking pay to a different variable,
let alone could that variable be identified with the length of service, or employee
“longevity”, which is traditionally typically used by the public sector employers.
Regardless of the method financial recognitions are granted to individuals,
these should be invariably offered to the best performers, rather than to the individuals
who, for instance, have worked for an organization for a longer period of time.
This being the case, the employer would seriously risk putting in place “the
wrong incentives” (Behn, 2004).

The main tenet at
the basis of this approach could then be considered inspired by the glaringly
obvious and it could hardly be argued that this approach should not be pursued
by organizations aiming at enhancing their overall organizational performance.
As suggested by the CIPD (2012), PRP actually represents a proper means to
effectively link individuals reward to the business aims and objectives; it
essentially enables employers to “ensure that organizational priorities become
individual priorities” (Torrington et al, 2008).

The role played by managers, as usually happens
during the execution phase of every type of strategy and practice, is clearly
of paramount importance. According to the tasks performed by each individual
within the organization, as far as applicable, these need to assign to their
direct reports objectives which essentially enable the organization to attain
its own objectives and strategy. Such an approach should in turn enable employers
to drastically improve the chances of attaining their intended results and
hence the desired level of organizational performance (Torrington et al, 2008).

Mismatch between
PRP designing and execution

Despite in theory
the PRP approach should represent the most effective means to reward people
within organizations, it is usually considered the cause of dire troubles and
difficulties when implemented in practice. It is indeed by reason of all the problems
it is supposed to cause that PRP has attracted fierce controversy ever since it
was originally developed and introduced within organizations.

The controversy
surrounding these types of arrangements is mainly based on the mismatch usually
identified between their theoretical development and their practical
implementation (Torrington et al, 2008). Armstrong (2010) maintains that the
effectiveness of this approach can be considered questionable in that,
especially when it was firstly introduced, it failed to fulfil the expectations
it had created, to wit: to strongly and successfully support the implementation
of cultural change. As anticipated above, the main problem occurs during the
schemes execution, rather than during their design and development. In many
circumstances, nonetheless, failure has also been directly caused by the
application of the wrong approach under the wrong circumstances.

So interesting this approach appears to be, as to
having attracted the interest of the public sector employers too. The debate
about the effectiveness of PRP within the public sector exploded anew in the UK
at the end of the last decade, when it was suggested to apply these arrangements
to the teachers of public schools (Torrington, 2008).

Arguments against performance-related
pay

PRP approaches are essentially
underpinned by the idea, which actually also represents a mandatory
prerequisite for its successful introduction, that individual performance can be
objectively, accurately and fairly measured, which in practice habitually
reveals to be a sorely difficult feat to perform.

As a consequence of
this theoretical assumption, the worth of the reward offered to the different
employees should be justified on the basis of objective grounds, that is, on
the basis of the results yielded by each individual, which should be in turn reflected
in the level of pay each of them receives. All of that makes sense as far as it
could be taken as axiomatic that individuals are willing to go the extra mile
and increase their level of performance in exchange for a more attractive
financial reward package (Armstrong, 2010).

The preconditions for the successful
implementation of a PRP scheme are to some extent self-explanatory and
essentially expounding why what has been even carefully designed and planned in
theory is likely to fail to achieve the intended results when implemented in
practice. With the exception of the cases in which the results yielded by a
working activity can accurately, qualitatively be measured, a fair and
objective assessment of the result produced by individuals usually reveal to be
an absolutely tricky feat to perform in practice, especially when the
calculation of pay increases and supplements is directly depending on these assessments.

It should not be
neglected that individual performance is, or rather, should be assessed by Line
Managers who, for different reasons, may be unable to fairly evaluate their
direct reports performance. The first reason for this could be represented by
managers showing, albeit inadvertently, bias or partiality; it is clearly unlikely
that LMs could actually be able to fairly and equitably assess their direct
reports work whether they have prejudices against some of them. Yet, in some
circumstances LMs could be urged to deliberately manipulate their direct
reports appraisal for “political reasons.” More specifically, LMs according to
the effects they feel performance appraisal is likely to have on their direct
reports could be tempted to tailor their judgements accordingly. Under such
circumstances, low and high ratings are craftily avoided in that likely to
impact interpersonal relations within the unit or group (Torrington et al,
2008). Boddy (2008), for instance, reports the case of a voluntary sector
organization where, as a consequence of the introduction of a PRP scheme,
performance appraisal scores tended to be “on the overly generous side.” This
surely had an evident impact on the organization’s personnel budget; on the
other hand a not equally evident improvement was recorded in employee
motivation and in individual and organizational performance.

Also the LMs lack
of capabilities and specific training, in addition to their lack of authority, can
seriously jeopardize the successful implementation of these programmes. In some
cases, even exactly determining who has to make the final decision about
individual pay can turn to be rather tricky. Despite as a general rule every
employee should have a manager, in some cases, especially when individuals work
in teams and projects, some employees might have more than one superior, with
the “official manager” possibly having little or no direct knowledge about the
performance of their direct reports. In such cases properly assessing
individual performance, and hence its impact on pay, may reveal virtually impossible
(Behn, 2004).

The rating assigned
by LMs to their reports performance in some cases may be also affected by
budgetary limitations. Under these circumstances, to curb the impact which the
implementation of PRP schemes has on the business budget, LMs deliberately
underrate the results yielded by the excellent performers (Torrington et al,
2008). Despite in this case LMs act just as mere executors of the directives issued
by the organization top management, these appear to their staff as those who are
treating individuals unfairly.

Budgetary
constraints can also emerge in a different way, for instance, by limiting or
reducing the number of individuals whom can be considered eligible for pay
increases. In those cases in which the number of people genuinely deserving a pay
increase or a bonus should exceed the limit dictated by the top management, the
effects produced by this type of measure would definitely be, to put it mildly,
counterproductive (Behn, 2004).

Considering the
impact which these pay arrangements can have on individual motivation, with specific
reference to the main features associated with the expectancy theory, that is, “expectancy”,
“valence” and “instrumentality”, research has produced mixed and contrasting results.
In those cases in which objectives were clear and compensation adequate PRP
schemes produced valuable results, whereas in the majority of the cases
investigated the underpinning elements of the expectancy theory remained unsatisfied
at large (Perry et al, 2009).

“Valence”, that is
to say the worthiness of reward and the importance individuals attach to it, clearly
also plays a role so that the pay increase of 3 percent habitually granted to
employees in association with the implementation of these pay arrangements can
hardly be considered attractive (Armstrong, 2010). This conclusion has been
confirmed by an empirical study conducted by Heinrich (2007), which revealed that
financial reward premiums associated with PRP schemes are usually too small to
be considered appreciable and valuable by employees. By contrast, in those
situations in which the amount of financial incentives is considered significant
by individuals, the implementation of PRP approaches may prompt individuals to
focus more on the aspects of their job which are most closely related to the
monetary aspect, whilst neglecting the others (Torrington et al, 2008).

Individual PRP
schemes can actually risk fostering an individualistic approach to work, to the
detriment of teamwork. Employees will clearly tend to focus more on the
activities enabling them to earn more considerable reward packages, to the
detriment of cooperating and teaming up with their peers.

It has not be overlooked that the expectancy theory
is based on the pivotal assumption that individuals have different wants and
differently value results (Boddy, 2008); this consequently implies that at best
pay increases do not attract all the employees in the same way.

An additional flip
side of these arrangements is represented by the counterproductive effects on
motivation these might produce the moment LMs unveil their staff ratings. Those
who receive higher or satisfactory ratings would obviously feel happy for the recognition
they receive. This does not necessarily exclusively relate to the financial
aspect of PRP, but also to the “mere” circumstance of having been positively
rated. Vice versa, those who have received unsatisfactory ratings clearly feel
disappointed for their work not having been considered valuable, the fact of
receiving or not receiving additional cash would just contribute to make things
harder. Yet, these employees could also disagree with their LMs for the rating
they have received, which they could consider biased and unfair especially
vis-à-vis those given to their peers.

To avert such circumstances
to occur and consequently to be managed, all too often LMs prefer avoiding to propose
low or even no financial recognitions for their direct reports. The consequence
of such behaviour is obviously considerably detrimental for two different reasons.
Firstly, this approach would clearly lead to a situation in which best
performers and worst performers are rated within a very narrow scale; occurrence
which produces in turn two negative subsets of effects: on the one hand worst
performers consider pointless going the extra mile, in that they already receive
the same, or nearly the same, pay increases or bonuses received by those who
have achieved better levels of performance; on the other hand such management
behaviour is perceived as unfair by best performers which consequently lose
faith in their management and in the way they treat their reports.

Secondly, this managers’ approach will surely
remarkably impact the organizations personnel budget. Employers would find
themselves in a situation to spend more with little, if any, justification for
a better ROI.

Nowadays businesses
are nearly constantly involved in the implementation of change so that in many
circumstances the attainment of individual objectives can be affected by it.
What can be considered as an organization’s priority and main aim today might
not be considered important tomorrow or even later today. Differently from what
suggested by Torrington et al (2008), nonetheless, this should not have a
considerable impact on the appraisal of individuals’ performance. This for two
different reasons: the fact that organizational objectives, and hence
individuals’ objectives, change does not entail that individuals performance may
not be properly assessed and evaluated; secondly, albeit organizational change may
lead to amend individuals objectives, this not necessarily prevent organizations
to attain theirs, at least in part. Once organizational objectives have been
subject to adjustments, these may be in turn changed to individuals. This process
might reveal not to be so straightforward; notwithstanding, change should not
represent a particular barrier to the successful implementation of PRP schemes.
Change is becoming increasingly frequent within organizational settings so that
managers need to learn to get along with it and be ready to face the side
effects this is likely to have.

One of the most
negative effects of PRP, nevertheless, is associated with individual growth and
development. When performance levels directly impact employees’ salary, individuals
tend to minimise and conceal their feebleness during the appraisal meetings
(Torrington et al, 2008). This clearly prevents employees and managers to have
an open dialogue and hence to properly determine the individual training needs and
identify the appropriate plan of action for improvement. This detrimental
effect can be averted keeping separated pay review and performance assessment from
development and growth planning, essentially performing the two activities in completely
different and separate occasions.

The criticism attracted by PRP schemes sorely
depends on its underpinning assumption that individuals are all motivated or
mostly motivated by cash. It would seem that the cash factor invariably is at
the centre of the employees’ attention, insofar as to influence, control and
guide their activities and behaviour, which cannot be indeed taken as axiomatic
and considered as a universal rule. This is actually the main reason why in
many occasions PRP schemes have failed. By contrast, when designed and
developed in presence of the right circumstances and in combination and synergy
with other initiatives these programmes can produce truly valuable results.

When PRP
approaches can actually work

Performance-related
pay approaches are beset with downsides, criticism and past and present
implementation failures. Notwithstanding, some studies carried out by Brown and
Armstrong (2000), the IRS (2005) and the IDS (2005) show that PRP approaches
can also successfully be introduced and implemented within firms. As these
studies suggest, PRP is likely to work only whether a few fundamental
preconditions are met:

a) It is properly
managed and implemented;

b) It is introduced
only in presence of the right and suitable circumstances;

c) The
implementation process is carefully prepared and sufficient time is allowed
prior of its practical introduction (Brown and Armstrong, 2000);

d) It is implemented
in combination with the other reward initiatives implemented by an employer in
that its successful or unsuccessful execution can impact, negatively or
positively, the other actions eventually co-ordinated by an employer to
motivate staff (Brown and Armstrong, 2000);

e) It is regarded as
part of a reward system formed by both financial and non-financial rewards (de
Silva, 1998).

The disgrace of PRP
is in part due to it having been in the past depicted as a universally
effective and powerful approach, capable of invariably producing dramatic
effects on individual motivation irrespective of the circumstances, which is
clearly far from being the case (Torrington et al, 2008).

PRP is not and
cannot be considered as an effective one-size-fits-all approach, but rather as
an additional tool employers can have recourse to, whether and when
appropriate, in order to try and influence employee motivation. As a general
rule, this type of programmes can actually reveal to be effective in those
cases in which:

- Individual
performance can objectively be measured;

- Individuals have a
complete control of the results produced by their work and a precise cause–effect
relationship between these can be clearly identified;

- Neither teamwork
nor cooperation with other colleagues has significant effects or impact on the
results yielded by an individual;

- The introduction
of these pay arrangements is supported by a rather individualistic organizational
culture (Gomez-Mejia and Balkin, 1992).

Whether an employer
fostering a culture based on teamwork and collectivist principles should introduce
these pay arrangements, this move would immediately be interpreted by employees
as sorely inconsistent and lacking of integrity.

Research has
revealed that PRP approaches are more likely to be effective and successful in
those organizations where objectives are clearly shared and understood by
staff, compensation is considered adequate and organizational culture supports
merit-pay schemes (Greiner et al, 1977). According to de Silva (1998), also the
existence within the organization of a performance management process,
nonetheless, represents a mandatory requirement. The PM process should ensure
that some crucial activities have been prepared and performed (IDS, 1997); amongst
these gains a particular significance organizational planning, meant as the
definition of the objectives and the identification of the main skills required
to effectively attain these. The targets clearly need to be set according to
the overall organizational strategy and aims, and should be openly and appropriately
communicated to the individuals concerned. The identification of the performance
measurement and ratings, on the basis of which salary increases and bonuses
will be offered, is clearly of paramount importance, too. In order for PRP
schemes to be successfully implemented performance management should also take
into due consideration and wisely balance the individual aspirations and wants with
those of the employer.

As discussed
earlier, the line managers’ importance and full involvement in the process is clearly
crucial. LMs should be appropriately and thoroughly trained and ready to take
responsibility to conduct performance management.

The existence of a
PM process relying on these pillars can actually reveal to be particularly
useful to enable employers to successfully implement PRP schemes. Their failure
is more often than not due to the employees’ lack of understanding and acceptance
of both the pre-set objectives and the method performance and results will be
measured. Yet, performance appraisal systems directly linked to performance pay
and PRP approaches exclusively relying on financial rewards are amongst the
most recurring causes for these programmes failure (de Silva, 1998). Providing
individuals opportunities for personal growth, training and involvement, in
addition to obviously enhance employees satisfaction, would indeed enable these
to acquire additional skills and capabilities, become more confident and hence
perform better and more effectively contribute to the attainment of the organizational
objectives.

The findings of an empirical study carried out
in the Netherlands (Gielen et al, 2006) revealed that the introduction of PRP schemes
has a robust and direct positive impact upon labour productivity (+9 percent). The
study (which involved organizations with more than 100 employees) also revealed
that this increased level of productivity did not cause any contraction on the businesses
recruitment activities; by contrast, a 5 percent long term employment growth was
reportedly due to the introduction of these programmes. The Authors also report
a substantial increase of PRP popularity amongst Dutch firms, albeit not related
to a widespread confidence amongst employers of the positive role played by these
programmes upon productivity (Gielen et al, 2006). The rate of Dutch organizations
having recourse to PRP schemes has actually increased from 29 percent in 1995
to 51 percent in 2001, with the most remarkable growth recorded within the construction
sector organizations (+55 percent).

Longo, R., (2012), Performance-Related Pay, does this approach still work?, HR
Professionals, Milan [online].For an extended version of this article and much, much more click here